Early contracts for renewable electricity

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1 Report by the Comptroller and Auditor General Department of Energy & Climate Change Early contracts for renewable electricity HC 172 SESSION JUNE 2014

2 Our vision is to help the nation spend wisely. Our public audit perspective helps Parliament hold government to account and improve public services. The National Audit Office scrutinises public spending for Parliament and is independent of government. The Comptroller and Auditor General (C&AG), Amyas Morse, is an Officer of the House of Commons and leads the NAO, which employs some 820 employees. The C&AG certifies the accounts of all government departments and many other public sector bodies. He has statutory authority to examine and report to Parliament on whether departments and the bodies they fund have used their resources efficiently, effectively, and with economy. Our studies evaluate the value for money of public spending, nationally and locally. Our recommendations and reports on good practice help government improve public services, and our work led to audited savings of almost 1.1 billion in 2013.

3 Department of Energy & Climate Change Early contracts for renewable electricity Report by the Comptroller and Auditor General Ordered by the House of Commons to be printed on 26 June 2014 This report has been prepared under Section 6 of the National Audit Act 1983 for presentation to the House of Commons in accordance with Section 9 of the Act Amyas Morse Comptroller and Auditor General National Audit Office 24 June 2014 HC

4 This report examines the rationale for the FIDeR scheme and the value for money of these early contracts. National Audit Office 2014 The material featured in this document is subject to National Audit Office (NAO) copyright. The material may be copied or reproduced for non-commercial purposes only, namely reproduction for research, private study or for limited internal circulation within an organisation for the purpose of review. Copying for non-commercial purposes is subject to the material being accompanied by a sufficient acknowledgement, reproduced accurately, and not being used in a misleading context. To reproduce NAO copyright material for any other use, you must contact Please tell us who you are, the organisation you represent (if any) and how and why you wish to use our material. Please include your full contact details: name, address, telephone number and . Please note that the material featured in this document may not be reproduced for commercial gain without the NAO s express and direct permission and that the NAO reserves its right to pursue copyright infringement proceedings against individuals or companies who reproduce material for commercial gain without our permission. Links to external websites were valid at the time of publication of this report. The National Audit Office is not responsible for the future validity of the links /14 NAO

5 Contents Key facts 4 Summary 5 Part One Final Investment Decision enabling for Renewables 11 Part Two Scheme rationale 17 Part Three Outcome of the process 25 Appendix One Our audit approach 43 Appendix Two Our evidence base 45 The National Audit Office study team consisted of: George Last, David Howes, Stanley Kwong and Eric Lewis, under the direction of Jill Goldsmith. This report can be found on the National Audit Office website at For further information about the National Audit Office please contact: National Audit Office Press Office Buckingham Palace Road Victoria London SW1W 9SP Tel: Enquiries: Website:

6 4 Key facts Early contracts for renewable electricity Key facts 8 contracts awarded under the Final Investment Decision enabling for Renewables Scheme to: five offshore wind farms, two coal plants converted to biomass, and one biomass-combined heat and power plant 16.6bn cost to consumers of these contracts over their lifetime, assuming projects commission on time and at their full capacity ( prices undiscounted) 5 months minimum acceleration of certainty of support from early contracts relative to first allocation round of the main Contracts for Difference regime 17.7 million megawatt hours 324 million megawatt hours renewable electricity expected from these eight projects in 2020 if they reach their target capacity, before adjusting for transmission losses Department s estimate of the UK s total electricity generation in per cent estimated proportion of total electricity the eight projects awarded contracts will generate in per cent Department s estimate of the minimum proportion of total electricity required from renewable sources to meet the UK s 2020 renewable energy target 4548 megawatts renewable generation capacity these projects should provide 6.9 billion estimated funds available for all contracts for renewable electricity projects from to , including these early contracts ( prices undiscounted) 4 billion estimated cost of support to these eight projects under the Final Investment Decision enabling for Renewables scheme from to , assuming projects commission on time and at their full capacity ( prices undiscounted) 58 per cent proportion of the estimated funds available for all contracts for renewable electricity projects taken by these eight projects from to

7 Early contracts for renewable electricity Summary 5 Summary 1 The Department of Energy & Climate Change (the Department) implements energy policy, with three main objectives: provide a secure energy supply; decarbonise the energy supply; and ensure affordable energy for consumers. 2 The Department is responsible for achieving UK climate change commitments. The UK is committed under an EU directive to ensuring that 15 per cent of the energy it uses comes from renewable sources by To meet this commitment the Department estimates that in 2020 at least 30 per cent of UK electricity needs to come from renewable sources. The Climate Change Act 2008 also commits the government to reduce UK greenhouse gas emissions in 2050 by at least 80 per cent from 1990 levels. 3 To help achieve these objectives, the Department has used the Renewables Obligation to encourage investment in renewable generation. The scheme requires electricity suppliers to pay for Renewables Obligation Certificates. These give renewable generators a premium over the wholesale price for each unit of electricity they supply. 4 As part of its plans for electricity market reform the Department is establishing the Contracts for Difference scheme to replace the Renewables Obligation. Contracts for Difference will set a price for the electricity low carbon generators generate (known as the strike price ). A newly formed Counterparty Body will pay generators the difference between the market price and the strike price for the electricity they generate, where the strike price is higher. If the market price is higher than the strike price generators will pay the difference to the Counterparty Body. To enable it to make payments, the Counterparty Body is funded by electricity suppliers which may pass their costs on to consumers. The Department expects to award the first contracts under the main Contracts for Difference regime in December The Renewables Obligation will close to new projects in April While developing the main Contracts for Difference scheme in 2011, the Department recognised that developers of low carbon electricity plants, particularly of new nuclear power stations, might delay final investment decisions until they could receive a contract in late It therefore included in the 2012 Energy Bill the potential for the Secretary of State to award early contracts for difference to enable developers to take these final investment decisions as soon as possible.

8 6 Summary Early contracts for renewable electricity 6 In March 2013, the Department launched a distinct scheme to award early contracts to renewable generation projects at risk of delay. This scheme was called Final Investment Decision enabling for Renewables (FIDeR). The Department received 57 applications for FIDeR and signed contracts with eight projects in May 2014, subject to European Commission state aid approval. Two of the contracts are for power plants converted from burning coal to biomass, five are for offshore wind farms and one is for a purpose built biomass plant providing heat as well as power. Scope 7 Our audit addresses the value for money of the contracts awarded under the FIDeR scheme. We evaluated the FIDeR scheme on the following criteria: Were the Department s rationale and selection of projects, to award contracts, clearly defined and informed by robust evidence? How well has the scheme met the Department s objectives, and achieved good value for money for consumers? Our methodology is set out in Appendix One. Key findings 8 The Department s early contracts are part of its transition to a reformed UK electricity market, designed to attract investment in low carbon generation while offering improved value for money and better cost control. Contracts for difference under the full electricity market reform regime will be available to nuclear and fossil fuel plants with carbon capture and storage as well as renewables. They should offer better value for money than the existing Renewables Obligation, primarily by guaranteeing the price for each unit of electricity generated which should lower financing costs. For industry the change involves transition from automatic entitlement for Renewables Obligation support for eligible projects, to applying for contracts awarded from a set budget. This gives the Department better control over the costs of support. Early contracts are a component of the transition to this reformed electricity market (paragraphs 1.5 to 1.7). 9 The Department consciously chose to seek applications before deciding how much renewable generation it wanted from early contracts or whether to cap the budget it would allocate to them. The Department announced its intention to provide transitional support arrangements in It launched the scheme in March 2013 to identify the projects that industry considered were at risk of an investment hiatus, making clear that it was making no firm commitment as to the scale of the scheme. At this stage the Department was aware that if all projects which had expressed interest were awarded early contracts, this could commit nearly half the available budget for renewables contracts for difference in The Department did not determine how much capacity it was seeking from the scheme, nor did it set a budget at this stage. It set the budget for the scheme in November 2013 to enable contracts to be given to the top quarter of qualifying projects in each technology (paragraphs 2.5 to 2.9).

9 Early contracts for renewable electricity Summary 7 10 The early contracts for eight projects have given those developers certainty of support at least five months earlier than under the full Contracts for Difference regime. The Department s rationale for the scheme was to prevent a hiatus in investment in renewable electricity, enabling developers to take significant or final investment decisions ahead of the full Contracts for Difference regime, the timing for which was uncertain. When the Department invited applications in March 2013, it expected to award early contracts in autumn 2013, a year ahead of the first contracts under the full regime. But the Department subsequently delayed awarding early contracts until April If the European Commission gives state aid approval for early contracts for the eight projects in July 2014, their developers will be certain of consumer funded support at least five months before award of contracts under the first round of the full regime, currently planned for December Developers binding applications stated that without early contracts their projects would be cancelled or delayed by at least 12 months and in one case 24 months (paragraphs 3.2 to 3.5). 11 The Department s assessment of applications tested risks of delay or cancellation, prospects of timely delivery, contributions to development of renewable technology, and affordability. The Department reviewed applicants statements of the risks to their projects if they did not get an early contract. The Department used its own staff and those from the Department for Business, Innovation & Skills and external consultants to score projects on deliverability and contributions to development of renewable technology. The Department s heads of specialism then moderated those scores. The Department s process obliged it to award contracts to all projects it judged eligible and affordable (paragraphs 2.13 to 2.22). 12 We estimate that the early contracts have committed up to 16.6 billion or 58 per cent of the funds available for renewable contracts for difference to This has given the UK s renewables industry greater confidence in the near term but increased the risk of obtaining support for later projects. Early contracts have given certainty of support to a range of projects and investors in offshore wind and biomass. They are likely to have helped secure other projects progress and supply chain jobs and investment, including Siemens investment in wind turbine production and installation facilities in Yorkshire, valued at 160 million. They have also proved the commercial viability of contract terms and conditions for major renewables developers. But the scale of the early contracts has increased the risk for later investors of not getting support (paragraphs 3.9 to 3.12). 13 The early contracts support generation which will help meet the UK s 2020 renewable energy targets, but it is not clear that the full scale of these commitments was needed so soon. The early contracts can provide 5 per cent of total electricity in 2020, though developers may reduce their initially planned capacity by up to 36 per cent without penalty. It is possible that the combination of capacity already operating or with planning consent, and early contracts would more than meet the total capacity from wind and biomass conversion that the Department considers necessary by 2020 to meet the renewables target. But this will depend on attrition rates for projects with planning consent. Even had some capacity been lost or delayed because it did not receive an early contract, the Department might still expect to meet its targets (paragraphs 3.6 to 3.8).

10 8 Summary Early contracts for renewable electricity 14 The early contracts have been awarded with administratively set strike prices which may provide higher returns than needed to secure the investment. The Department set the strike prices to align them with the support available under the Renewables Obligation drawing upon independent advice and reduced strike prices for five technologies following public consultation. The Department considered these prices represented value for money because at that stage they were the same prices it expected to set for the full Contracts for Difference regime. However, administratively set prices may be higher than needed because: The Department set strike prices for early contracts at a level designed to encourage the investment needed to meet its decarbonisation objectives. Strike prices are set for each technology rather than negotiated with individual projects. They are designed to offer an acceptable return to the most expensive viable project (the marginal project) needed to meet decarbonisation objectives (paragraphs 3.14 to 3.17). Developers are likely to progress those projects offering the most promising returns first, so these early projects may well be those that will benefit most from administrative prices (paragraph 3.14). The Department did not ask for information on estimated project costs and returns, for its own evaluation, since it was not setting project-specific strike prices. It sought that information from applicants to enable the European Commission to consider the risk of over-remuneration as part of its state aid review. The Department has not required contract holders to give information about actual costs and returns (paragraph 3.28). The Department offered the same strike price to all phases of offshore wind projects, denying consumers the opportunity to share in any benefit for developers as technological innovation reduces costs. Developers of offshore wind projects have stated that they undertake procurement for all phases of a project at the start of the first phase and do not expect to benefit from cost reductions in later phases (paragraph 3.19). The Department has not included provisions to clawback a share of any excessive returns in early contracts. It considered that to do so might deter prospective investors (paragraph 3.27). 15 The Department s decision to award up to 16.6 billion of early contracts without price competition limits the budget available for later allocation rounds that can use price competition. The Department proceeded with the scheme while recognising that it did not bring a clear monetised benefit and acknowledging that competitive pricing might reveal subsequently that some administratively set strike prices were too high. It considered early contracts would bring wider benefits to the industry; and the contracts were designed to offer better value than the Renewables Obligation. The Department told us it now expects to apply price competition to up to 40 per cent of the total budget for contracts for difference for renewables between now and 2021 (paragraphs 3.31 to 3.33).

11 Early contracts for renewable electricity Summary 9 16 The contracts contain provisions that require active management to protect value for money for consumers. Their design includes provision for adjusting strike prices, validating power output, and reviewing measures of market prices. The Counterparty Body which will manage these contracts is currently being formed. Under a Framework Agreement, the Department will require the Counterparty Body to seek to maintain investor confidence in the Contracts for Difference regime and minimise costs to the consumer. Active and effective management of these provisions is essential to ensure contract costs are minimised for consumers (paragraphs 3.23 to 3.25). Conclusion on value for money 17 Early contracts for renewables have helped industry confidence in the near term and the projects they support can make a significant contribution to meeting the UK s 2020 renewable energy target. The contracts themselves are designed to offer better value for money than the Renewables Obligation they replace. But the contracts have been awarded without price competition and with administratively set strike prices which may provide higher returns than needed to secure investment. We are not convinced that it was essential to award so much consumer support to early contracts in order to meet the 2020 renewables target. Awarding so many early contracts of this scale in this way has limited the Department s opportunity to secure better value for money through competition under the full regime which will start to award contracts in December of this year. The value from the early contracts is in part the learning they can deliver to help transition towards a competitive regime for contracts for difference but this value will be lost if the Department does not get competition into place while a substantial part of the funding remains available. Recommendations 18 The Department should ensure that it maximises the opportunity for price competition under the Contracts for Difference scheme. It could do this by dividing the available budget between technologies and commissioning years, so it is likely to be less than demand, and trigger competitive auctions. Where it has good evidence that the continued availability of support under the Renewables Obligation is preventing genuine competition for strike prices, it should consider reducing the availability or level of Renewables Obligation support. 19 The Department should include clauses in future Contracts to enable it to clawback excessive returns achieved by individual projects. It should also consider including provision for reducing strike prices for multiphase projects, for example where there is clear evidence of a significant fall in financing, capital or operating costs since the first phase.

12 10 Summary Early contracts for renewable electricity 20 The Department should require holders of all contracts for difference including early contracts to give information on their actual costs and returns. This will let the Department judge whether strike prices are giving expected returns, and use clawback provisions where returns exceed set limits. 21 The Department should get information from developers on how projects which have been awarded early contracts have contributed to developing the renewables industry in the UK. The Department evaluated developers applications for an early contract partly against how they contribute to developing renewable industry supply chains, workforce capacity and renewable technology. It plans to collect information from developers as part of its benefits management strategy. It should ensure it assesses how and whether these claims were realised. It can use this information to help evaluate future contract bids. 22 The Department should ensure the Counterparty Body actively manages contracts to minimise their costs to consumers while meeting its objectives. The Department should resource the Counterparty Body to review and challenge generators claims for increases in strike prices, identify opportunities to reduce strike prices, and check metered output and indices of market prices.

13 Early contracts for renewable electricity Part One 11 Part One Final Investment Decision enabling for Renewables 1.1 The Department of Energy & Climate Change (the Department) implements energy policy, with three main objectives: to provide a secure energy supply; to decarbonise the energy supply; and to ensure affordable energy for consumers. 1.2 The Department is also responsible for meeting UK climate change commitments. The government is required by an EU directive to get 15 per cent of energy consumed in the UK from renewable sources by 2020, with interim targets of 4.04 per cent across 2011 and 2012, and per cent across 2016 and In the longer term, the government is legally obliged to reduce UK greenhouse gas emissions by at least 80 per cent by 2050 from 1990 levels. The Department has estimated that the UK needs at least 30 per cent of its electricity generation to come from renewable sources by 2020 in order to meet its renewable energy requirement. 1.3 The Renewables Obligation has been the main support scheme to encourage investment in low carbon electricity generation. Since 2002, the Renewables Obligation has given generators a premium for each megawatt hour (MWh) of renewable electricity they generate. Income from the Renewables Obligation offsets the high cost of setting up and running renewable energy plants. The proportion of the UK s electricity generated from renewable sources has increased from 2 per cent in 2002 to nearly 14 per cent in The UK met its 2011 and 2012 interim target for energy from renewable sources.

14 12 Part One Early contracts for renewable electricity 1.4 Since 2011, the Department has been developing electricity market reforms to encourage investment in renewable and other low carbon electricity. It is doing this to help the UK to meet its renewable energy and decarbonisation targets, while maintaining supply and controlling costs for consumers. These reforms were enabled in the Energy Act 2013, which made the following changes: Renewables Obligation Closing the Renewables Obligation to new plants commissioning after 31 March The scheme will continue to pay premiums already committed until Contracts for Difference Establishing this new scheme to support new low carbon generation projects commissioning from 1 April The government expects to award its first contracts to renewable generators under this scheme by the end of Capacity Market Establishing a Capacity Market for support payments from to ensure sufficient generating capacity from non-intermittent electricity sources (such as gas and coal plants) or to ensure major energy users are ready to reduce their demand when necessary so that supply meets demand. 1.5 Contracts for difference offer low carbon electricity generators an agreed price for the electricity they generate (known as the strike price ). A government owned Counterparty Body 1 will pay generators the difference between the market price of electricity (known as the reference price ) and the strike price. If the market price is higher than the strike price, generators must pay the difference back to the Counterparty Body. The Counterparty Body recoups its costs from electricity suppliers. Electricity suppliers may then pass the costs on to consumers. The government has capped the total cost to consumers of contracts for difference by including them within the Levy Control Framework. The Framework caps existing levy-funded schemes including the Renewables Obligation Contracts for difference should be able to attract investment in a wide range of low carbon generation while offering better value for money and cost control than the Renewables Obligation because: a b The contracts will be available to all types of new investments in low carbon technology, that is nuclear power and fossil fuel power stations fitted with carbon capture and storage, as well as renewable electricity. The contracts give generators a shorter, 15-year period of support compared to the 20 years under the Renewables Obligation. 1 The Counterparty Body will be formed as The Low Carbon Contracts Company 2 Comptroller and Auditor General, Department of Energy and Climate Change: The Levy Control Framework, Session , HC 815, National Audit Office, November 2013.

15 Early contracts for renewable electricity Part One 13 c d The contracts should offer better value for money than the existing Renewables Obligation, primarily by guaranteeing the price for each unit of electricity generated which should lower financing costs. The Department sets budgets and rules for allocating contracts. It can control the number and scale of projects receiving support, and the costs of that support. This is in contrast to the Renewables Obligation, which supports any project that meets eligibility criteria. 1.7 The Department has valued the benefits of the Contract for Difference scheme at 10.7 billion (discounted, 2012 prices) up to This is compared to continuing with existing policy instruments only, principally the Renewables Obligation and carbon pricing. 1.8 While developing the main Contracts for Difference scheme in 2011, developers of low carbon electricity plants, including some new nuclear reactors, raised concerns around uncertainty for projects requiring final investment decisions before contarcts were due to be generally available. The Department recognised these concerns in its July 2011 white paper, and announced its willingess to engage with developers to address consequent risks of project delay or cancellation in its December 2011 technical update. It included in the 2012 Energy Bill the potential for the Secretary of State to award early contracts for difference to enable developers to take these final investment decisions as soon as possible. Since 2012, the Department has been negotiating one early contract with the promoters of a new nuclear plant at Hinkley. It also maintained contact with developers of renewable generation projects. 1.9 In March 2013 the Department set up the Final Investment Decision enabling for Renewables (FIDeR) scheme, to mitigate the risk of a delay to investment in renewable energy. The Department received 57 applications for an early contract through the FIDeR scheme. In April 2014, it announced the award of investment contracts that are early contracts for difference, for eight renewable electricity generation projects and signed contracts in May. Two of the contracts are for coal plants to convert to biomass, five are for offshore wind farms and one is for a dedicated biomass plant providing combined heat and power (Figure 1 overleaf) We estimate that the total lifetime cost to consumers of the eight early contracts awarded could be up to 16.6 billion (undiscounted, prices). This is assuming all projects commission at their target commissioning date and at the full capacity stated in their contracts and is based on the Department s assumptions on load factor and wholesale price (Figure 2 on page 16). The cost of the contracts for consumers depends on: the difference between the wholesale electricity price and the contract strike price; and the amount of electricity the plants produce. If the projects achieve their full capacity and commission at the start of their target commissioning window, they will produce 264 million megawatt hours of renewable electricity over their lifetime. So, the cost of support per megawatt hour is 63.

16 14 Part One Early contracts for renewable electricity Figure 1 The early renewable electricity generation contracts The Department awarded contracts to eight projects, commissioning from 2015 to 2019 Projects Technology Target commissioning date Teesside Renewable Energy Project Drax 3rd Conversion Unit (Unit #1) Lynemouth Power Station Beatrice Offshore Wind Farm Phase 1 Beatrice Offshore Wind Farm Phase 2 Burbo Bank Extension Offshore Wind Farm Dudgeon Offshore Wind Farm Phase 1 Dudgeon Offshore Wind Farm Phase 2 Dudgeon Offshore Wind Farm Phase 3 Hornsea 1st GW Offshore Wind Farm Phase 1 Hornsea 1st GW Offshore Wind Farm Phase 2 Biomass combined heat and power Biomass conversion Biomass conversion Offshore wind Offshore wind Offshore wind Offshore wind Offshore wind Offshore wind Offshore wind Offshore wind Contract term or fixed end date Capacity developer aims to install (megawatts) Strike price ( / megawatthour, 2012 prices) Strike price ( / megawatthour, prices) Cost of support ( bn, prices) 31/07/ years /02/ /12/ /03/ years /03/ years /03/ years /03/ years /08/ years /10/ years /03/ years /03/ years Hornsea 1st GW Offshore Wind Farm - Phase 3 Walney Extension Offshore Wind Farm Phase 1 Walney Extension Offshore Wind Farm Phase 2 Offshore wind Offshore wind Offshore wind 31/03/ years /03/ years /03/ years Total 4,

17 Early contracts for renewable electricity Part One 15 Figure 1 continued The early renewable electricity generation contracts Administrative strike prices by commissioning date and technology (2012 /MWh) Biomass conversions Dedicated Biomass with CHP Offshore wind Notes 1 Contracts for the biomass conversion projects are subject to a fi xed end date of The Department published strike prices in 2012 prices, they are shown here in both 2012 and prices adjusted using the consumer prices index. 3 Cost of support is in prices and is undiscounted. Discounted to present ( ) values at a discount rate of 3.5 per cent, the cost of support is 11.4 billion. 4 We have calculated the cost of support on the basis of the capacities and target commissioning dates provided by the project developers in their applications to the scheme, using the Department s load factor assumptions and wholesale price projections from the Department s, Electricity Market Reform Delivery Plan central scenario, December Under the terms of the contracts, projects may deliver less than these capacities and may commission within the 12-month target commissioning window after the target commissioning date. To assess the cost of these projects, the Department has assumed that some projects have a reduced capacity and commission after the target commissioning date. On this basis, the Department s central estimate of the cost of support is 15.4 billion, undiscounted, ( 10.3 billion discounted to present values, at a 3.5 per cent discount rate). 6 Data may not sum due to rounding. Source: Department of Energy & Climate Change 1.11 One of the applicants is also receiving government backing in other forms. The Drax biomass conversion has a loan from the government owned, but independent, Green Investment Bank. Drax also has a UK government guarantee for a 75 million loan to the company. The terms of this other support can take account of the fact that the project has been awarded a contract under the FIDeR scheme. We are reviewing the government s programme for Loan Guarantees with a view to reporting our findings in autumn In this report we address the value for consumers from these early contracts, in particular addressing: the scheme rationale and how the Department selected the projects to award early contracts, in Part Two; and the outcome of the process compared to the Department s rationale and the resulting value for consumers, in Part Three.

18 16 Part One Early contracts for renewable electricity Figure 2 Cost to consumers of the eight early contracts The total lifetime contract cost to consumers of the eight early contracts awarded could be up to 16.6 billion million 1,400 1,200 1, Walney Extension Offshore Wind Farm all phases Beatrice Offshore Wind Farm all phases Hornsea 1st GW Offshore Wind Farm all phases Drax 3rd Conversion Unit (Unit #1) Dudgeon Offshore Wind Farm all phases Lynemouth Power Station Burbo Bank Extension Offshore Wind Farm Teesside Renewable Energy Project Notes prices, undiscounted. 2 Cost of support is in prices and is undiscounted. Discounted to present ( ) values at a discount rate of 3.5 per cent, the total cost of support is 11.4 billion. 3 We have calculated the cost of support on the basis of the capacities and target commissioning dates provided by the project developers in their applications to the scheme. We have used the Department s load factor assumptions and wholesale price projections from its Electricity Market Reform Delivery Plan central scenario, December Under the terms of the contracts, projects may deliver less than these capacities and may commission within the 12-month target commissioning window after the target commissioning date. To assess the cost of these projects, the Department has assumed that some projects have a reduced capacity and commission after the target commissioning date. On this basis, the Department s central estimate of the cost of support is 15.4 billion, undiscounted, ( 10.3 billion discounted to present values, at a 3.5 per cent discount rate). Source: National Audit Office

19 Early contracts for renewable electricity Part Two 17 Part Two Scheme rationale 2.1 The Department established the Final Investment Decision enabling for Renewables (FIDeR) scheme to enable developers of renewables projects to take final investment decisions which would otherwise be delayed by the uncertainty caused by transition from the Renewables Obligation to the Contracts for Difference regime. It also aimed to provide proof of concept for the Contracts for Difference regime and explore the application of the contracts to a range of renewable energy technologies. 2.2 In this part we look at how the Department: assessed the value of early contracts and its business case; and addressed its rationale for the scheme in deciding which projects to give contracts to. Evolving rationale and business case 2.3 From 2011, the Department developed proposals for early contracts for difference for renewable generation projects, based on the business case for the wider programme for Electricity Market Reform. In 2012, the Department developed its case for the Final Investment Decision enabling (FIDe) programme and in November 2012 it published its impact assessment for the FIDe programme, covering proposed early support for new nuclear power, carbon capture and storage projects and renewable electricity. This estimated a net benefit of 2 billion from the impact of the proposed early contract for a nuclear power station. The Department s analysis did not consider the costs and benefits of the two offshore wind farms in isolation from those of the nuclear power plant and so did not identify any distinct benefit from awarding early contracts to the two offshore wind farms. 3 We estimate that the notional costs of support to the two offshore wind farms were 3 billion over the lives of their contracts at 2013 prices. 3 DECC, Impact Assessment: Electricity Market Reform (EMR) Final Investment Decision (FID) Enabling, April 2012, available at:

20 18 Part Two Early contracts for renewable electricity 2.4 Following discussions with 12 developers over the period from 2011, the Department launched the FIDeR scheme in March 2013 for projects that were at significant risk of delay or cancellation if they were required to wait for the main Contracts for Difference regime. It allowed applications for early contracts from those renewable electricity technologies eligible for the Renewables Obligation. The Department told us this was necessary to remain neutral in their approach to different renewable technologies: In 2011, the Department had considered there was only a case for awarding contracts to projects that might not commission in time to get Renewables Obligation support. The Department judged that although the Renewables Obligation would continue for projects commissioning before April 2017, projects due to commission shortly before 2017 might not proceed given the risk of slipping beyond eligibility. Subsequently, the Department accepted that some projects that could commission well before April 2017 might still be delayed because financiers intended to wait until a contract for difference could underpin revenues. The Department also considered that extending eligibility to such projects might benefit the UK s security of supply. For example, if proposed biomass conversions failed to secure early contracts the unconverted power stations might be forced to close, with a potentially significant impact in the short term on the UK s capacity margins. 2.5 The Department launched the expanded FIDeR scheme in March 2013, with applications to participate required by 1 July 2013 and the intention to award the contracts in autumn This Phase 1 of the scheme was designed to identify those projects that considered they were at risk of delay. Stakeholders we spoke to confirmed that the intention to award early contracts to this timetable, a year ahead of the Contracts for Difference regime, addressed a genuine risk of investment hiatus. Launching the scheme with wide eligibility criteria raised industry expectations. At this stage the Department was aware that if all projects which had expressed interest in early contracts were awarded them, spend under the scheme could represent 49 per cent of the total available budget for contracts for difference in But the Department chose not to set a budget for the scheme at this stage. The Department made no firm commitment to industry as to the scale of the scheme, but informed them that it might impose caps on the total funding for early contracts or the budgets made available for different technology types, or both. The Department drew up an outline business case for the scheme in May 2013.

21 Early contracts for renewable electricity Part Two In June 2013, the Department decided it needed to put back the final award of early contracts to March 2014 as the contract terms to be used for the early contracts (and later for all contracts for difference) were not yet sufficiently well defined. This delay also allowed the Department to align the early contract strike prices with the final strike prices for the main Contracts for Difference regime that it planned to publish in December The decision to continue with the scheme to this revised timetable was not supported by detailed quantitative economic analysis of the continuing benefits case for the scheme. The Department intended to undertake an economic analysis for its full business case in December The Department proceeded with the scheme in June 2013 on the grounds that the contracts were needed to prevent a significant hiatus in investment in new renewable electricity generation and there was continuing uncertainty surrounding the timetable for the Contracts for Difference regime, as it depended on achieving Royal Assent of the Energy Bill in December The Major Projects Authority reviewed progress on the scheme in June Among its findings, it noted that the Department had not yet clarified its success criteria for the scheme, to allow flexibility in its operation. The Authority made recommendations to the Department on clarifying success criteria and on quantifying, measuring and evaluating benefits. In response, the Department developed a plan, showing how it proposes to monitor the impact of projects that receive contracts on the renewables industry and on achieving the UK renewable energy target. 2.8 In value-for-money terms, the decision on what budget to allocate to early contracts was critical. However, the Department did not reach a final decision on this until November The more money it allocated to early contracts with strike prices set administratively, the less was likely to be available later. The Department set the budget for early contracts high enough to allow the highest ranked 25 per cent of qualifying applicants from each technology to get contracts. This meant three offshore wind projects and one each of onshore wind, biomass conversion and biomass combined heat and power. It set budgets before performing the ranking, so that it did not prejudice which specific projects could be considered affordable. The Department therefore had to assume the top 25 per cent of projects for each technology were also the biggest, or it would risk being unable to fund the largest projects from each technology that had met minimum evaluation thresholds. The Department therefore set the budget for early contracts for the period to at 4.7 billion ( prices). 4 Based on the applications received it was not possible to spend all of this budget because the Department would not be able to match projects starting in different years precisely to the annual spending limits within the budget and because it expected projects to be delayed. 4 The Department published its budget in prices at 4.5 billion. This is equivalent to 4.7 billion in prices using the consumer price index.

22 20 Part Two Early contracts for renewable electricity 2.9 In November 2013, the Department considered this budget would result in it spending 48 per cent of the funds available within the Levy Control Framework caps for all contracts for difference for renewables to , after taking into account the need for a contingency budget. It acknowledged that competitive pricing in the longer term might reveal certain administrative prices had been too high, but also that others may have been set too low. Although the Department expected the Contracts for Difference regime would enable competition in the long run, it considered that initially contracts for less established technologies would be awarded administratively set prices on a first-come first-served basis. It would move to allocation of contracts at fixed times of the year, within fixed budgets, on the basis of price competition where demand for contracts exceeded the available budget The Department s economic analysis at this time showed that awarding early contracts to a potential combination of projects did not have significant monetised costs or benefits compared to alternative scenarios where the scheme did not proceed and projects were delayed or cancelled. The Department s scenarios were for all projects being delayed or all being cancelled. The Department did not consider scenarios with different outcomes by technology or project, nor assess different scales for the scheme and scenarios including future competition to reduce strike prices The Department s investment committee approved the full business case to proceed with the scheme in December The business case showed there was no clear monetised benefit from the scheme, but identified potential benefits that had not been monetised, which it considered outweighed potential risks to value for money. These were: showing that contracts for difference were viable, before the enduring regime; reducing industry costs, for example by supporting early supply chain development and by enabling a steady pipeline of projects; and minimising the risk of penalties for failing to meet the UK s 2020 renewable energy target and interim targets, by ensuring new capacity could proceed quickly. Moreover, the Department felt that cancelling the scheme would undermine the confidence of the renewables industry in market support in the UK The Major Projects Authority reviewed the Department s final business case for the FIDeR scheme in January 2014, noting that this business case depended on unquantified benefits. It commended the Department s process for selecting projects and the positive impact on achieving value for money, but noted that there were risks to value for money because of the lack of price competition.

23 Early contracts for renewable electricity Part Two 21 Selecting projects 2.13 The Department selected projects for award of early contracts in three phases (Figure 3 overleaf): Qualification Evaluation Affordability selection Qualification 2.14 The Department established qualification criteria that ensured it could reject early speculative applications from projects that did not have detailed plans and could not give supporting evidence. Its qualification process required applicants to demonstrate: they had credible plans to start generating electricity by 31 March 2019; without an early contract there was a significant risk that the electricity generation to which the contract relates would not occur or would be significantly delayed; the project was not already accredited under the Renewables Obligation; an expected capacity of 50MW or greater, or in the case of an offshore project, 100MW or greater; and the project was located in the UK The Department wanted assurance on the risk of delay or cancellation. It required applicants to show the potential impact of waiting for the full Contracts for Difference regime on the timelines for their critical investment decisions and project commissioning. The Department required a warranted statement from applicants boards confirming the risk of delay or cancellation. The Department sought further clarification from applicants. But it did not attempt to rank or compare the severity of the risks cited, or the lengths of potential delays to commissioning. The Department told us that to do so would have been too onerous given the number of applicants and the difficulty of treating all applicants equally. Most projects which the Department disqualified did not yet have credible plans or were not eligible technologies. Two applications were disqualified because they did not give convincing evidence that they would face an investment hiatus Applicants with projects commissioning before 2017 could potentially choose between the Renewables Obligation and an early contract. To prove a risk of investment hiatus, they had to explain why support under the Renewables Obligation would lead to delay to or cancellation of the project. Drax sought early contracts for units it planned to convert to biomass. In April 2014, the Department awarded a contract to one unit but disqualified another which had been due to commission first. Drax is currently challenging the Department s decision through a judicial review.

24 22 Part Two Early contracts for renewable electricity Figure 3 The three-phase project selection process The Department awarded eight projects from 57 applicants in a three phase selection process Phase 1 Qualification (March to June 2013): 57 projects applied, 26 qualified. One project subsequently withdrew. Phase 2 Evaluation (September to December 2013): the Department scored and ranked detailed applications with minimum thresholds for continued inclusion in the process. Of the 25 remaining projects, 16 met minimum evaluation thresholds. Phase 3 An affordability selection process (December 2013 to April 2014): The Department assessed how many projects were affordable within its budget. Of the 16, ten were deemed provisionally affordable in December Before contracts were finally awarded, two onshore wind projects withdrew and one biomass conversion project was disqualified. The Department then awarded a contract to the next highest ranked applicant which was an offshore wind project. Technology Applied in Phase 1 Applied for Phase 2 Passed minimum evaluation thresholds Provisionally affordable in December 2013 Dropped out or disqualified Biomass combined heat and power Biomass conversions Dedicated biomass 3 Offshore wind Onshore wind Solar Power 7 Awarded contracts Energy from Waste Combined Heat and Power 3 Tidal range 1 Total Source: Department of Energy & Climate Change

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